CIO Market Update Audiocast Series​

Chris Hyzy:                This is Chris Hyzy, Chief Investment Officer, for the market update for October 25^th. The question we have today is a little different than previous calls. It focuses more on the risks out there. The big question is this, what’s the largest catalyst to pressuring the market in our opinion in the coming six to 12 months? Is it geopolitics? In our opinion, not likely. Is it US tax policy changes? Also not likely. Valuations in the equity market? Also not likely. The debt overhang that is often discussed? Not actually right now in our opinion, but perhaps years down the road. Oil prices? That is a likely catalyst to pressure the market. It depends on how high oil prices go in the coming 12 months and their stickiness in our opinion. Inflation could also be a large catalyst to pressure the market but in our opinion, inflation running ahead of expectations and monetary policy and the changes to monetary policy, in other words if the fed have to play catch up and do it very quickly, sharp interest rate increases at the short end of the curve are likely to be the largest catalyst to pressure the market in the next 12 plus months. As we get close to the next FOMC meeting and we hear more about fed communications about tapering as well as the potential for the futures market to adjust in the fed funds, futures market to short term rate expectations, we will watch and analyze this very closely. Fed communication between now and tapering, which is likely to be mid-November, if not December, and then fed communications between now and the potential for a bump up to short term rates some time next year and most likely some time around the September – November timeframe is very important to the markets overall. Preparing the markets for eventual fed lift off is very important. Now, sharp adjustments or sharp increases in short term rates could create a negative surprise overall so from five particular reasons – number one, it could spook the market, generally speaking, because of less liquidity which the market has been used to. Two, increases the potential cost of debt. Three, it signals a much slower economy in the future and that adjustment could occur at the back end of the curve which could flatten the curve which is number four, if not invert the curve if the fed increases rates very sharply. Five, initially correlations between treasuries and equities could be positive. In other words, if equity prices fall, it could likely also pressure bond prices at the same time. Now we will have much information to react to between now and then, but for now we continue to focus on the four Rs – robust revenue and earnings for the third quarter and fourth quarter guidance. Reopening of the service economy. As of right now, B of A Global Research’s proprietary indicators are still flashing green amongst a majority of the economic indicators. Last but not least, the restructuring to the supply of global supply chains overall that is already occurring in our opinion. Last but not least, the fourth R is a recycling of cash back into equity as we close out this year. We remain overweight equities as we believe corporate fundamentals are still improving and investor sentiment is still starting to stay guarded however, we expect the turn in investor sentiment as we close out the year. Again, corporate fundamentals are driving this reallocation of cash back into the equity market. As we sit here today, 117 companies have reported or about 33% of the overall S&P 500. They are tracking a 4% beat on earnings. The percentages of companies that are beating on earnings, sales, and both are approximately 79%, 72%, and 62%. How does this fare versus historical averages? It’s well above. Historical averages give us about 63% beats on earnings, 57% on sales, and only 43% on both. This time around it’s 79%, 73%, and 62%, providing a strong anchor to the denominator which is profits powering corporate fundamentals forward. Again, we remain overweight equities as we believe corporate fundamentals are still improving and investor sentiment is turning positive once again. We will assess risks over time. The biggest risk that we foresee is a sharp adjustment and change to monetary policy. In other words, a sharp upward move in interest rates where the fed has to play catch up. For now we focus on corporate fundamentals. That’ll do it for today. Thanks for listening.

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